Bank of England's QE2 may reach £500bn, economists warn

The Bank of England may have to inject as much as £500bn into the economy to
rescue Britain's faltering recovery, economists warned after the central
bank shocked markets by restarting its money printing programme.

Sir Mervyn King said the world had changed dramatically in the past three months – blaming slow growth in the US, China and Europe

Sir Mervyn King, Governor of the Bank, unveiled plans to increase quantitative easing (QE) from £200bn to £275bn – a sum equivalent to a fifth of the UK economy, as it held rates at 0.5pc. The Bank was taking the "pre-emptive action to prevent the slowdown becoming too serious", he said.

Markets welcomed the decision, which was roughly £25bn more and came one month earlier than expected. The FTSE 100 climbed 3.7pc, or 189.09, to 5,291.26, outpacing similar rises of more than 3pc in France and Germany. Reflecting the higher risk of inflation, the pound crashed by more than 1.5 cents against the dollar in the aftermath of the announcement, before recovering to close 0.41 cents down at $1.5384.

The move puts the Bank at odds with the European Central Bank (ECB), which kept rates on hold at 1.5pc on Thursday, and the US Federal Reserve, which recently decided against increasing its $2.3 trillion (£1.5 trillion) QE programme and instead switched short-term for long-term government debt in a policy called "operation twist".

Explaining the decision to launch what has become known as "QE2", Sir Mervyn said the world had changed dramatically in the past three months – blaming slow growth in the US, China and Europe. "These tensions in the world economy threaten the UK recovery," he said.

Weaknesses in the UK's major export markets have caused growth to "moderate". In addition, he warned, the eurozone's debt crisis is causing bank funding to dry up, which may trigger a second credit crunch that would hit already stretched households and businesses.

Explaining how the Bank's Monetary Policy Committee (MPC) justified the decision to start QE2 with inflation already more than twice above its 2pc target, he added: "The deterioration in the outlook has made it more likely that inflation will undershoot the target in the medium term." Inflation is 4.5pc and is expected to rise to 5pc next month.

Critics, though, said the Bank may have moved too soon. "The Bank is risking its credibility as defender of stable prices and, even if funding conditions for the UK's banking sector pick up, this will have more to do with developments in Europe than it will from QE," Kathleen Brooks, research director at Forex.com, said.

Others warned that far more QE than first time will be needed, as the policy cannot push the borrowing cost on Government debt much lower than it already is. Although benchmark 10-year gilts fell sharply in early trading, they closed four basis points higher at 2.39pc.

Michael Saunders, UK economist at Citi, said: "With the recent large deterioration in the economic outlook, the MPC will probably have to do QE on a very big scale. We expect the cumulative total will eventually reach £500bn or so. It may go even higher than that."

The Bank is sticking to its existing policy of only buying Government debt to keep risk to a minimum. Once complete, it will own 32pc of the total £860bn UK gilt market. At £500bn, it would hold two-thirds. It expects to complete the asset purchases over the next four months.